Healthcare valuation 101: Surgery center case study


The large, rapidly changing, and highly regulated U.S. healthcare industry is a significant user of valuation services. Jim Lloyd and Kathryn Culver, both of PYA, recently presented the BVR webinar Healthcare Valuation 101 and walked through a case study of a valuation in this complex industry.

Specifically, the case study is based on a situation in which their client engaged them to value a controlling interest in a multispecialty surgery center. Keep reading for the key facts of the case and be sure to watch the webinar clip below in which the presenters cover the case study in detail.


Case study details

The client, a national management company, wanted a fair market value opinion to help manage from a regulatory compliance perspective and also to assist with evaluating a transaction to ensure that it was not overpaying for the surgery center.

Key facts of the proposed transaction

  • At a high level, the valuation is for a 55% controlling interest with no discounts applicable;
  • No "certificate of need" (CON) is required for surgery centers in this particular state;
  • The center is in-network with all major commercial payers;
  • The surgery center is structured as a limited liability company (pass-through entity);
  • The multispecialty is performing cases in eight different surgical specialties;
  • There is approximately $5.2 million of net revenue and $1.6 million of EBITDA on a trailing 12-month basis;
  • There are 16 physicians—all anticipated to continue performing cases as normal post-transaction;
  • The surgery center was opened in 2006; it is fairly mature and stable, without substantial growth; 
  • There are two operating rooms and one procedure room; and
  • They are performing approximately 3,300 cases per year.

Historical financial and operational data

During this engagement, the presenters encountered a few high-level items that are important to take into account.

Balance sheet:

  • Analyze cash to determine whether any excess;
  • Analyze accounts receivable using an aging report;
  • Inventory not recorded—estimated based on historical purchases of medical supplies expense;
  • Analyze fixed assets by type and evaluate future capital expenditure needs;
  • Assess reasonableness of other accrued expense/liability accounts; and
  • Analyze interest-bearing debt and capital leases.

Income statement:

  • Analyze revenues by type of case and by physician;
  • Analyze operating expenses—based on year-to-year trends and as compared to benchmarks;
  • Facility leased from a related party. Analyze to determine whether lease rate is at fair market value;
  • Related party provides management and billing services. Adjusted management and billing expense to fair market value; and
  • Adjustments for nonrecurring expenses, e.g., one-time repairs and maintenance expense related to a water leak.

Other key factors:

  • Owner physicians perform approximately 90% of cases;
  • Several owner physicians are nearing the end of their career;
  • The center’s reimbursement is comparable to industry benchmarks (~$1,600 per case);
  • The center’s EBITDA margin is comparable to industry benchmarks (30%); and
  • The center has a favorable payer mix as compared to industry benchmarks (approximately 70% commercial vs. 59% benchmark)

Cash flow projections for DCF method

After performing the initial analysis, projections are made on the case volume by surgical specialty and by physician. Normally, there are ongoing discussions with the client, a site visit, etc.—it is a dialogue. Sometimes, the presenters will take the first pass at the projections based on the information gathered from the client and then review and refine it.

Revenue projections:

  • Analyze historical case volume trends by physician and discuss anticipated growth rates with management:
    • Project case volumes by surgical specialty and physician; and
    • Distinguish between physician owners and nonowners.
  • Analyze net revenue by type of case and by payer:
    • Discuss anticipated growth rates with management; and
    • Research regarding anticipated growth rates (e.g., Medicare Payment Advisory Commission “MedPAC” Report).
  • Evaluate/inquire about commercial payer contracts.

Expense projections:

  • Variable expenses: Typically projected based on case volume/revenue;
  • Fixed expenses: Inflation/contracts in place;
  • Evaluate current and future staffing needs based on anticipated case volume growth; and
  • Evaluate reasonableness of projected margins—as compared to historical results and benchmarks.

Projections are pretty straightforward. There may be different viewpoints, but the presenters say they generally almost always adjust cash flows even for pass-through entities/LLCs on an after-tax basis. In valuation, the healthcare industry is unique in that the hypothetical buyers and sellers can be individual physicians, nonprofit health systems, or for-profit entities.

Discount rate

The estimated discount rate is the weighted average cost of capital (WACC). The presenters use the buildup method to estimate the cost of equity because they did not have good guideline public companies to help evaluate the beta. This is what they currently do with regard to smaller healthcare entities.

Weighted Average Cost of Capital:

  • Utilize buildup method to estimate cost of equity due to a lack of publicly traded guideline companies. Identify risk factors including:
    • Physicians (several nearing retirement age);
    • Uncertainty regarding future reimbursement rates; and
    • No CON protection.
  • Utilize Moody’s Baa-rated corporate bonds as benchmark for cost of debt; and
  • Assume capital structure weighting of 70% equity and 30% debt. WACC = 13.5%.

Valuation methodology utilized

The presenters do not use an asset approach because it doesn’t make sense relative to the positive cash flow the surgery center was generating. They use the income approach—a discounted cash flow method—but do not use the market approach. There are no (or not enough) publicly traded guideline companies.

For more on this webinar and healthcare valuation-related sessions, check out our full calendar of upcoming webinars and past events. To listen to the complete Healthcare Valuation 101 webinar in which the presenters cover additional case studies, check out the training pack.

Additional information can also be found in The BVR/AHLA Guide to Healthcare Industry Finance and Valuation, 4th edition.


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